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TradeStation Group, Inc. (NASDAQ:TRAD)

Q2 2008 Earnings Call Transcript

July 24, 2008 11:00 am ET

Executives

David Fleischman – CFO

Salomon Sredni – CEO

Analysts

Justin Hughes – Robertson Stephens Inc.

Edward Ditmire – Fox-Pitt Kelton

Rich Repetto – Sandler O'Neill & Partners

Operator

Good afternoon, my name is Diana and I will be your conference operator today. At this time, I would like to welcome everyone to the TradeStation Group second quarter 2008 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator instructions) Thank you.

Mr. Fleischman, you may begin your conference.

David Fleischman

Thank you, Diana. Good morning and welcome to the TradeStation Group second quarter 2008 conference call. Today's conference call is being broadcast live over the Internet and will be archived for the next 90 days at www.tradestation.com. We would like to thank all of our listeners, including shareholders, customers and analysts for joining us this morning.

My name is David Fleischman, Chief Financial Officer of TradeStation Group. Here with me today is Salomon Sredni, our Chief Executive Officer. By now, you should have seen our financial results released this morning. If you have not, they are available at our company web site, www.tradestation.com, in the Investor Relations section. Also, if you are accessing this call through our web site, please note that some of the prepared comments you are about to hear are accompanied by graphs and charts, and we invite you to view them as you listen.

Before we start, I would like to emphasize that this conference call will include statements that are forward-looking and are made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act. All forward-looking statements are based on current expectations and beliefs and actual results may differ materially from the results suggested in this conference call. Factors that may cause or contribute to such differences include those set forth in today's earnings release, and in the company filings with the Securities and Exchange Commission. Please note that the company undertakes no obligation to update any information presented in this call. With that said, it is my pleasure to hand over the call to Salomon Sredni, Chief Executive Officer of TradeStation Group.

Salomon Sredni

Thank you, David. Good morning everyone. The 2008 second quarter, as you all have probably seen by now, was really another example of strong financial performance for TradeStation despite the challenges imposed by the decrease in volatility that we saw when we look at the second quarter compared to the first quarter of this year.

Our brokerage revenues and commissions year-over-year increased by 24%. Our commissions on fees were driven by a large year-over-year increase in DARTs which was 28%, and brokerage account growth also continued to be strong this quarter.

Let me provide some color on a few of those numbers. Year-over-year, as I have said, we increased our DART in the 2008 second quarter to over 91,000 which, although was lower than the DARTs reported in the 2008 first quarter, it is still is a 28% increase when you look at DARTs year-over-year. Please keep in mind once again that these DARTs are produced by roughly just 40,000 accounts, a powerful statement to the leverage of our active trader business model. This is obviously a small fraction of the number of accounts that our larger competitors require to produce that many trades. We once again attribute our DART growth to the growing diversity of our service offering and robustness of our business model. Through July 22, our DARTs for this month were over 110,000 DARTs, a very strong showing.

Let's now spend a moment on brokerage accounts. Our over 2,000 new accounts in the 2008 second quarter that we added have brought us nearly to 41,000 total accounts; a record total and a 20% increase in the size of our customer base year-over-year. As I mentioned last quarter in this call, we expect our attrition to be higher in the 2008 third quarter which could result in lower net new account adds if we do not meet our gross account add goal for the quarter. Having said that, we remain excited about our prospects for customer account growth going forward.

Last week, I hope you all saw, we launched a new flat-fee commission plan offering what we believe will help us penetrate a valuable segment of the active equities trader market that we think we've barely touched to date. What we are talking about is the traders that trade a high number of shares per ticket for whom our per share commission pricing plan becomes too expensive at a certain point. I would certainly discuss that after David’s presentation in today’s call.

The numbers of our brokerage accounts generated also continue to be among the very best in the industry. During 2008 second quarter, on an annualized basis, our average account traded over 575 times and the average account produced over $3,400 of revenue. Both numbers are obviously substantially higher than those produced by the majority of our competitors.

At this point, what I’ll do is I’ll the turn the call over to David so he can go over our second quarter 2008 performance from a financial perspective. He will turn then the call back to me and I’ll review some of these points in further depth.

David Fleischman

Thank you, Sal. For those of you listening through our TradeStation web site, we again invite you to view the graphs and charts accompanying my comments.

For the quarter ended June 30, 2008, TradeStation Group had net income of $6.1 million or $0.14 per share. During the quarter, as previously disclosed and as had been included in our business outlook, the company incurred an additional $1.2 million stock compensation as a result of the early vesting of certain Officers and Directors' stock options. Partially offsetting this expense, not anticipated in our business outlook, the company recorded the recovery of $625,000 of legal fees in a final settlement with an insurance carrier.

TradeStation Group’s 2008 second quarter net income of $6.1 million or $0.14 per share compared to 2007 second quarter net income of $8.1 million or $0.18 per share, and 2008 first quarter net income of $8.3 million or $0.19 per share. If you would exclude the one-time, pre-tax expense of $1.2 million, an after-tax expense of $800,000 or $0.02 per share relating to accelerated vesting of certain Officers and Directors' stock options that occurred as result of the collective beneficial ownership of the company by the company’s co-founders falling below 25%, 2008 second quarter net income would have been $6.9 million or $0.16.

When comparing the 2008 second quarter reported results with the 2008 first quarter, the variance was primarily the result of lower commission and fees due we believe to reduced volatility in the markets and lower net interest income due to reduced interest rates, partially offset by lower expenses.

As compared to the 2007 second quarter, the variance was primarily the result of lower net interest income of $4.7 million year-over-year reduction due to reduced interest rates and increased expenses.

Second quarter 2008 net revenues of $36.6 million increased 2% when compared to second quarter 2007 net revenues of $35.8 million, and decreased by 10% when compared to 2008 first quarter net revenues of $40.7 million. Compared to the 2008 first quarter, the variance was primarily the result of lower commissions and fees due to reduced volatility in the markets and lower net interest income as a result of reduced interest rates.

During the 2008 second quarter, the average closing of the Vics [ph] was 20.7, a 21% reduction as compared to the 2008 first quarter average of 26.1. Compared to 2007 second quarter, the minor increase in net revenues was the result primarily of increased commissions and fees due to increased market volatility and account growth, almost totally offset by lowering net interest income due to reduced interest rates.

Brokerage commissions and fees of $28.2 million increased 24% from second quarter of 2007 brokerage commissions and fees of $22.7 million. Increased market volatility combined with continued account growth were important factors helping us achieve this 24% increase.

Second quarter 2008 net interest income of $6.2 million was a 43% decrease from second quarter 2007 net interest income of $10.9 million and a 23% decrease from first quarter 2008 net interest income of $8.1 million. This decrease was a result of lower interest rates.

On April 30, 2008, the federal funds target rate of interest was reduced by 25 basis points to its current rate of 2%. Most of our interest income is tied to the federal funds target and daily rates of interest. We estimate, based upon the size and nature of our customer assets as of June 30, 2008, that each basis point increase or decrease in the federal funds target rate of interest impacts our annual net income by approximately $65,000. Increases or decreases in our aggregate customer cash balances will also affect net interest income.

In preparing our 2008 third quarter business outlook that was published today, we assumed there will be no further increases or decreases to the federal funds target rate of interest for the remainder of 2008.

TradeStation's second quarter 2008 brokerage commissions and fees per employee, which were over $85,000, were about 38% higher than TD Ameritrade's and about 76% higher than E-Trade's brokerage commissions and fees per employee. This highlights the scalability and leverage of our business model.

During the 2008 second quarter, total expenses were $26.5 million, 73% of net revenues as compared to $22.8 million, 64% of net revenues in the 2007 second quarter, and $27.2 million, 67% of net revenues in the 2008 first quarter. Compared to the 2007 second quarter, the dollar amount increase of total expenses was primarily the result of increased stock compensation, increased execution costs due to a higher number of customer trades, and as we continue to grow our accounts and revenues, our increased investment in people and infrastructure.

Compared to the 2008 first quarter, the dollar amount decrease was primarily the result of lower execution costs and legal fees, partially offset by increased tax compensation cost. For both periods, the increase of total expenses as a percentage of net revenues was caused mainly by our decrease in net interest income which has no corresponding cost.

For the 2008 second quarter, employee compensation and benefits was $10.8 million as compared to $8.8 million in the 2007 second quarter due mostly to a one-time increase in stock compensation cost as a result of accelerated vesting of certain Officers and Directors' stock options and increased employee headcount. At June 30, 2008, the company had 341 employees as compared to 313 employees at June 30, 2007. As discussed in previous conference calls, in 2008, we have planned and is our intention to continue to increase our employee headcount primarily in product development.

For the 2008 second quarter, clearing and execution of $8.5 million, 30% of brokerage commissions and fees compared to 2007's second quarter clearing and execution of $7.5 million, 33% of brokerage commissions and fees, increased trading volume and mix of business accounted for the variance in the 2008 second quarter.

Data centers and communication costs in the 2008 second quarter were $2.4 million as compared to $1.5 million in the 2007 second quarter. Beginning in the 2007 third quarter, the company began classifying a portion of its recovery of exchange fees within brokerage commissions and fees. Together with the effect of that classification, higher location costs and data fees primarily accounted for the increase.

Second quarter 2008 professional services were $159,000 million as compared to $204,000 million in the 2007 second quarter. During the 2008 second quarter, the company recorded a $625,000 recovery of legal fees from the insurance carrier as part of the final settlement of coverage relating to certain lawsuits in which the company had prevailed or had settled.

Second quarter 2008 advertising, occupancy and equipment costs, and depreciation and amortization costs were approximately the same as the 2007 second quarter. Second quarter 2008 other costs were $1.4 million as compared to $1.6 million in the 2007 second quarter. The favorable variance was primarily the result of the company recording in the 2007 second quarter a $450,000 increase in a reserve pertaining to issues relating to now resolved regulatory matter, partially offset by increased customer debits and errors, costs for training and workshops and supplies.

In the 2008 of second quarter, company pursuant to its stock by stock buyback plan spent approximately $3.7 million to purchase approximately 384,000 shares of its common stock. Since buying under the plan began November 13, 2006 through June 30, 2008, the company spent approximately $24.5 million to purchase approximately 2.1 million shares.

In this morning’s earnings release, we issued out business outlook for the 2008 third quarter. We are estimating for the 2008 third quarter that net revenues will range from $37 million to $42 million and earnings per share will range from $0.15 to $0.19.

When preparing our current business outlook, we assumed, among other things that the account will average of daily revenue per account for each asset class at approximately the same level they averaged during the six-month period ending June 30, 2008. And that for the reminder of 2008 there will be no further changes to the federal funds target rate of interest currently at 2%. Variations in these or other assumptions will likely result in material differences to the estimated results in the business outlook.

That concludes my prepared remarks today concerning our financial statements. I will now turn over the call back over to Sal.

Salomon Sredni

Thank you, David. As I have mentioned earlier in our call, we continue to be very excited about growth and product penetration of the US active equities trader market.

Last week, we announced a new flat fee commission plan which is really driven at getting large share traders into our fold. I am talking about those traders that trade anywhere from 1,500 shares to 500 shares per trade.

We believe that our larger competitors, their average customer trades about 2,000 shares per trade and I want to contrast that with our average which is closer or in the range of 300 to 400 shares per trade. So when you think about it, historically, we have made it cost prohibitive for this type of traders to take advantage of our functionality and our state of the art technology.

This offering is really focused on attracting those customers into our fold. We believe they stayed away as a result of the cost.

With this new flat fee commission plan, those traders will be able to pay a flat commission rate ranging from 6.99 to 9.99 depending on how active they are. We are really looking forward to seeing what kind of response we will get on this offering as we roll out our advertising and continue to educate new prospects on this new offering.

By offering our customers choice and letting them choose the commission plan that best suits them, we have further enhanced one of the main attractions of our brokerage firm, empowering our customers to trade the way they want to trade.

We also now have in beta scheduled for a full rollout later in the third quarter the next version of TradeStation, and that is TradeStation 8.4.

TradeStation 8.4 has several features which we believe will continue to enhance our leadership in the active trader market. Included in TradeStation 8.4, which again is in beta right now, is the new TradeStation Scanner. Using this new functionality, a trader will now be able to specify virtually an unlimited set of technical or fundamental data criteria and then in just a few seconds, scan the entire stock, futures, options and ForEx markets to instantaneously produce a list of all securities that meet that criteria.

But that is not all. The trader is not limited to the menu of criteria we provide. He or she can customize that criteria based on their own logic, for their own rules, with virtually no limitations, and then they can the scan the markets based on that custom criteria.

We believe this depth of functionality is not available anywhere else in the retail market today. We see the TradeStation Scanner as an incredibly powerful new tool for traders to search across entire markets, to identify securities that meet their rules and strategies to buy and sell.

In this new version of TradeStation, we also have dramatically enhanced our hot list feature. Hot lists are errant [ph] lists of securities based on predetermined criteria. In effect, they are (inaudible) market-wide scans such as stock that are closed to a 52-week high or above or well below the 52-week low.

Until now, these criteria have solely been tied to price. But with the new version, we’ve added over 70 new predetermined scans that cover not only price indicator of securities, but also indicators that relate to volume, volatility and options.

For the trader who does not want to do a more detailed or customized criteria using the

TradeStation Scanner, this new hot list feature provides a diverse, easy to use menu that enables the trader to instantly rank all the securities that meet numerous different kinds of trading rules the trader wants to use to find again buy or sell opportunities.

Also in 8.4 is the new learning center which in effect will be inside our platform. With the newer learning center, customers will no longer need to visit our web site support center to see basic tutorials about how to get started with and use our platform. Now, once a new or existing customer logs on to a platform to begin using it, he will be able to click on a menu of visual audio tutorials that will lead him through the use of the functionality he has selected. This will include, thanks to our recently released real-time trading simulator, real-time real-world examples on how to use their platform's functionality pretty much in its entirety.

We see this enhancement as an important step to help new accounts get up and running and trading sooner and we will leverage this to educate both new and existing customers on the valuable analysis and trading features of our platform. To help remain ahead of our competition, we also have several other enhancements and features in the works.

As I stated previously, I will be sharing those with you as they are closer to the release. We continue to believe that electronic, automated, rule-based trading, the core of our award winning service offering and a unique selling proposition should appeal to the special demands of the active trader market.

Rule-based trading is relevant to all serious traders and most serious and active traders today do use one kind or another to make the trading decisions.

They are not throwing darts at a dartboard and we believe we can help them. What we offer, we believe, better than anyone else is a platform that helps rule-based traders become disciplined rule-based traders, which we think improves both their trading confidence and abilities. That is why we continue to be so excited about what we are doing here.

We think that our market will expand as more and more traders, both domestically and abroad, see the value of becoming more disciplined rule-based traders.

I once again want to take this opportunity to thank our employees for their outstanding achievements and their continued dedication and focus. We are truly blessed. I continue to be extremely excited about our team, and the potential we have to grow this company to a new level. That concludes my prepared remarks for today's presentation, and I will now ask the operator to open the floor for questions.

Question-and-Answer Session

Operator

(Operator instructions) There are no questions at this time, sir.

David Fleischman

Okay. Well, thank you. There being no further questions, so no questions at all. We would like to thank all of you for joining us this morning. We appreciate your support and look forward to our next conference call.

Operator

Excuse me, Mr. Fleischman.

David Fleischman

Yes?

Operator

We do have a few questions that’s just come in, one moment.

David Fleischman

Okay.

Operator

The first question comes from the line of Justin Hughes.

Justin Hughes – Robertson Stephens Inc.

Hey, good morning and congratulations on a good quarter.

David Fleischman

Hey, Justin, good morning.

Justin Hughes – Robertson Stephens Inc.

There was a mention in the release that you expect attrition to increase after going down the last couple of quarters. I’m just wondering why it’s been coming down after kind of peaking mid last year. Why do you expect it to go back up?

David Fleischman

Justin, the third quarter, historically for us and I understand for the industry, normally has increased attrition. We saw it last year. We see it again this year. Attrition sort of spiked in last year’s third quarter and that sort of stabilized or came down after that. This year third quarter, we again see a spike. Remember that for an account to be attrited, they have to be out of our midst for over 180 days, so third quarter tends to be higher for us because what we’re seeing is accounts which change basically brokers at the beginning of each year which only seems normal. So we get a lot of new accounts in the first quarter and where accounts we attrite in the fourth quarter and start showing up in the third quarter. Do you follow that?

Justin Hughes – Robertson Stephens Inc.

Yes, so it’s a seasonality issue. It’s nothing specific to anything going on in the industry or volatile of the markets, it's a seasonality issue?

David Fleischman

I don’t think I can attribute it to anything in the market. What can I tell you and my understanding is that, it’s not just us, a lot of people switch accounts in the first quarter so we saw that spike. Remember that we’ve also continued to – so there’s a lag between we add – as we’ve added new accounts at a greater rate, eventually you start losing some of those accounts so that catches up with you as a lag. But I don’t think there’s an industry-wide issue or problem that you can derive from this.

Justin Hughes – Robertson Stephens Inc.

Okay, my second question, I know you guys are always kind of conservative in how you do your interest rate forecast just assuming the current rates. But you announced Fed fund futures are estimating that rates are more likely to go up and your balances appear for margins and cash to be higher than they were at year-end. So can you update us on your interest rate sensitivity?

David Fleischman

Yes, Justin. I think in my script I said that it’s about $65,000 of each change in the basis point.

Justin Hughes – Robertson Stephens Inc.

And I believe (inaudible) net income after tax, correct?

David Fleischman

Yes, that is net income after tax. That is correct.

Justin Hughes – Robertson Stephens Inc.

As per basis point?

David Fleischman

Per basis point.

Justin Hughes – Robertson Stephens Inc.

Okay, thank you.

Operator

Your next question comes from the line of Edward Ditmire.

Salomon Sredni

Hi, Ed, good morning.

Edward Ditmire – Fox-Pitt Kelton

Good morning guys. I’m sorry if I might have missed this earlier in the call, but did you guys comment at all on the July month to date trends, volumes in all the product groups, your customers are big in US cash equities, equity index, futures and equity options are pretty dramatically sequentially?

Salomon Sredni

Through July 22, our DARTs have been averaging 110,000, so we clearly are feeling what you see out in the marketplace and we like it.

Edward Ditmire – Fox-Pitt Kelton

Okay, thank you.

Salomon Sredni

No problem.

David Fleischman

Thanks, Ed.

Operator

Your next question comes from the line of Rich Repetto.

Rich Repetto – Sandler O'Neill & Partners

Good morning guys.

David Fleischman

Good morning, Rich.

Salomon Sredni

Good morning, Rich.

Rich Repetto – Sandler O'Neill & Partners

I guess, first question, you talked a lot about some, what sounds like pretty neat functionality and beta test. Any metrics of quantification, how does this change behavior, just trying to get our arms around what’s the real value being delivered at the functionality?

Salomon Sredni

That’s very difficult to measure, Rich. What we’re trying to do is obviously continue to enhance our lead and continue to develop functionality, a, it’s helpful to our traders, our customers to identify trading opportunities and help them trade the way they want to trade as we said, and enhance their abilities to be disciplined in the trading. It’s very difficult to link that with what kind of lift we may have or what kind of impact we’ll have on account growth. All I can tell you is that we believe that the TradeStation Scanner is very unique and something that customers will very much embrace. It’s very unique to our functionality.

Rich Repetto

Okay. And then, relative to this quarter’s advertising spend, are you not supported with any incremental advertising spend or this is sort of baked into the – the run rate shouldn’t change I guess would be the opposite of that question.

David Fleischman

We don't expect the advertising run rate to change this quarter.

Rich Repetto – Sandler O'Neill & Partners

Okay. And then the SEC short-sale rule making it a little bit difficult and it appears time consuming to at least on the financial stocks. I’m just trying to see any impact there and then, I guess, you are view of whether it impacted those bonds [ph] beyond the 19 financials?

Salomon Sredni

Rich, great question. We haven’t seen much impact from that to date. Obviously, what the SEC is trying to do is making it virtually impossible to short those stocks and what the SEC wants to virtually do virtually happens. So I think you will see much less of those stocks being shorted. So obviously, it diminishes that. They’ve limited to a certain amount of symbol, so we haven’t felt a tremendous impact. But obviously, to the extent they extend it, it will limit the opportunities our clients might have to short a particular security they want to short. But again to date, it hasn’t been a huge deal.

Rich Repetto – Sandler O'Neill & Partners

Okay. And then I guess my last question guys is, I think this has been asked before, but you see the Ameritrade and Schwab certainly moving towards more focused asset accumulation strategies and they say they haven’t given up the focus on the active trader. But now, with your flat fee commission, have you seen any opportunities because of the strategies or is it an easier game out there? Or are things about the same, that you really haven’t seen changes competitive despite their quite broader strategies?

Salomon Sredni

You know, Rich, we live (inaudible) we’re very excited about our focus strategy and we know who we’re going after and we continue to enhance our platform. Our account growth speaks for itself. I think that obviously they have their strengths and their weaknesses. We have our strengths and our weaknesses. But we continue to feel very confident that if you are not good trader, there’s really honestly no reason now that we don’t put prices and issue for you, for you to be anywhere else but TradeStation. So we are very much, with open arms, welcoming any active trader that is ready to have the ultimate trading platform.

Rich Repetto – Sandler O'Neill & Partners

Okay. And one last one, a quick question. The different asset classes are – options are growing off the charts and I guess the question is, any mix shift in the trades at TradeStation that your clients are gravitating to, any material mix shift?

David Fleischman

Basically, each quarter, the mix sort of changes around. It depends on the volatility within the classic [ph] list. As we said before, basically, we’ve seen over the past number of years, the revenue is growing and at this point, it’s still over 50% of our total business.

Rich Repetto – Sandler O'Neill & Partners

Okay. Thanks guys.

Salomon Sredni

Thank you, Rich.

Operator

There are no further questions at this time, sir.

Salomon Sredni

Okay, well thank you. There being no further questions, we'd like to thank all of you for joining us this morning and look forward to our next conference call. Thank you very much.

Operator

Thank you for participating in today’s conference. You may disconnect at this time.

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